The Dubious Joy of Budgets

If you're the type of person who always has plenty of cash, knows exactly where every penny goes and never has trouble paying bills, skip this article. You're either too rich or too smart to need it.

For the rest of us, unfortunately, making -- and sticking to -- a budget is the essential tool for ensuring that our money gets used the way we need it to. And even if you're in the happy situation of having plenty of income, the homework involved in drawing up a budget can be instructive since you may find that you are spending more than you wish on items like music CDs, electronic gadgetry or restaurant meals.

Not that drawing up a budget is any barrel of laughs. On the contrary, it's pure drudgery enlivened only by the occasional anguish of staring your own foolish spending habits square in the face. In fact, one of the chief impediments to budgeting is that most people would rather not know how they really use their money. It's bad enough to learn this kind of information on your own. It's even worse when a spouse or significant other finds out, since it usually confirms his or her worst fears -- and provides new ammunition for future "discussions."

Take heart. However unwise you are about spending your money, others are likely to be just as foolish in their own way. Moreover, the pain of budgeting comes mostly at the beginning. After you have a budget in place, and you've fine-tuned it with a couple of months of actual spending, then tracking your expenditures becomes almost automatic. If your boss at work were to ask you for an analysis of the department's spending, you'd figure it out quickly enough. Budgeting your household should be approached in the same businesslike fashion. And there are a variety of ways that electronic tools can make the process easier.

Getting Started

To build a realistic budget, start by figuring out where your money goes now.
There are three steps to creating a budget:

1) identify how your money is currently being spent,

2) evaluate that spending to see if it meets your financial priorities, and

3) track your ongoing spending to make sure it stays within those guidelines (or to understand how your budget needs to be revised).

If you happen to use Quicken, Microsoft Money or other such software, you're in luck. These programs generally make it easy to draw up a budget.

In Quicken, for example, every time you make a deposit, write a check, pay a credit card bill or dispatch an electronic payment you are asked to assign it to a particular category, such as "salary," "clothing," "groceries," "child care" or "health insurance." You can also create subcategories, dividing "auto" expenses into "fuel," "insurance" and "service." The program comes with a set of categories that handle most of the basics. You can edit the list to create categories that make better sense for your particular household. And if you're away from home, you can track expenses at the Quicken website and then download the transactions to your hard disk later.

The drawback, of course, is that entering and categorizing all of your income and outflow is a truly tedious chore.

You can reduce the tedium to some degree by judicious selection of categories. Let's say you are only worried about tracking your spending for recreation and leisure pursuits. You could create categories that cover those types of expenses, and let everything else accumulate under "miscellaneous revenue" or "miscellaneous expense."

The problem with that approach is that you forgo the opportunity to spot problems in other spending areas that you may not even be aware of. So a better solution is to track expenses using electronic banking. That way, you can download your payments and deposits directly from the bank, rather than having to enter them by hand.

The downloaded banking transactions generally show up without any categorization -- meaning you'll have to add the categories by hand. But if you use a credit card that is issued by a bank that permits electronic access, then the downloaded charges from your card sometimes do come with categories attached (they aren't always right, so check them).

Either way, once you've got your spending tracked by category, then drawing up a report requires only a few clicks of the mouse. Even better, such programs often have an automatic budget-creation feature that scans your spending in the past in order to estimate how much you'll spend going forward.

If your finances aren't wired, you can still get a good handle on your spending the old-fashioned way. Start by getting all your records together from the past 12 months, including pay stubs, loan proceeds, withdrawal slips, canceled checks and itemized credit-card statements. Then go through them and compile totals for your income and expenses in a set of categories that make sense for you.

At the end of this exercise, you may still have a sizable lump of spending that's undocumented -- typically, the money you withdraw in cash and then spend on day-to-day needs. If this portion of your budget is more than about 5 percent of your total spending, you ought to go through one further step to understand where it is going. That is, keep a journal for the next four weeks in which you record every nickel you spend. You can use those results to extrapolate how your cash is being spent throughout the year.

Now that you've got a good picture of where your money is going, you can proceed to evaluate which parts of that spending should be raised or lowered. Next month we'll talk more about that.

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